COMMENT: Croatia's two main parties neck and neck in latest polls

By bne IntelliNewsNovember 15, 2007

Raiffeisenbank in Zagreb -

The sixth parliamentary elections since independence in 1991 will be held in Croatia on November 25. The current prime minister, Ivo Sanader, from the Croatian Democratic Union (HDZ), has headed a centre-right coalition since 2003. Up to now, the HDZ has won all but one of the general elections. In 2000, the Social Democratic Party (SDP) came to power leading a centre-left coalition.

Polls indicate that these elections will be a neck-in-neck race between the HDZ and the SDP, and that both will probably have to rely on other parties to form a coalition. A grand coalition is very unlikely.

The focus of the election campaign is on current socio-economic issues, but this does not rule out populism and granting of extraordinary benefits to please the electorate. Nevertheless, it is noteworthy that this year's elections have not negatively impacted the budget, due to the solid business activity.

Foreign investors have not worried too much about the upcoming elections up to now, and they have been pretty right in not doing so. Most of the still-needed structural reforms that should support and improve the business climate and economic growth are defined by the process of EU accession, which is backed by an overwhelming national consensus. Neither the HDZ nor the SDP is interested in altering Croatia's Euro-Atlantic integration efforts and its pro- Western course.

We believe that the elections should not cause any repercussions on financial markets and asset prices. The free-floating but tightly managed kuna should not feel the elections at all. The same holds true for domestic currency bonds. The only, albeit highly unlikely, scenario that might slightly dent foreign investor's appetite for Croatian assets (namely equities and Eurobonds, both of which saw fairly good performance in 2007) might be a very long delay in the formation of a government. However, repercussions on these markets will still be limited, as they are crowded with domestic investors (eg. domestic investment and pension funds). Our positive medium-term view on the Croatian equity market should be supported by a decline in uncertainty after the elections and announced further privatization to be conducted via the stock exchange as well as signs of further IPOs by private companies.

Economic and political review

In the economic sphere, the track record of the current government is a mixed bag. Based on our latest forecasts, average annual GDP growth will amount to 4.7% in the period from 2004 to 2007 (the period current government might have influenced economic performance). Under the previous government (2000 to 2003), average growth stood at 4.6%. Thus, average growth has not improved.

Furthermore, the main growth drivers remained the same from 2000 on, as household consumption and capital investments contributed the most to GDP growth.

However, one must take the different external conditions into account. For instance, in 2003 Western Europe as well as CEE economic growth was more sluggish, while Croatia was one of the fastest growing economies in Europe. If we compare Croatia's 2006 GDP growth with other SEE countries and take Western Europe's positive economic activity into account, one notices that Croatia achieved below-average growth. Nevertheless, growth rates have increased over the years to above 6% in January-June, which will result in annual growth for the whole year of above 5%. However, this trend was once again driven by strong domestic consumption stimulated by several factors: increased disposable income due to strong growth of loans to individuals, increased social transfers, repayment of debt to pensioners and surging (domestic) equity markets. Social transfers could be interpreted as election goodies to please the electorate.

Inflation (and inflation expectations) remained stable and predictable from 2004 to 2007, despite inflationary pressure stemming from international markets. Nevertheless, increasing oil and commodity prices on the world markets pushed CPI inflation above 3% in 2005 and 2006. In the first half of this year, inflationary pressures declined, partly due to the government decision to set price caps for the most used petroleum products and to adjust excise taxes. Incentives for these actions might be also found in pre-elections efforts, as rising inflation is perceived by voters promptly and companies might have used rising inflation for a shift in prices. However, recent data do confirm that inflationary pressures are on the rise again and volatile food prices might push annual inflation above the 4% level in the fourth quarter.

Since 2002, positive trends have been recorded on the labour market, as the number of jobless as well as the unemployment rate inched down (from 21% to 15% in 2007 with record low unemployment in summer). However, unemployment rates remain high by international standards (official unemployment rate: 15%, ILO unemployment rate: 10%). Structural problems, reflected in mismatch unemployment, can also be seen on the labour market. There is a growing discrepancy between supply and demand as Croatia is importing manpower in some special fields, while general unemployment remains at high levels.

According to official estimates, this year's government deficit should come in below 3% of GDP. However, the lower-than-expected deficit is a result of higher-than-expected revenues (driven by favourable tax revenues due to solid economic activity) rather than eager fiscal consolidation. Fiscal policy remained expansionary, keeping expenditures in relation to GDP at very high levels. All in all, the government in power did not manage to cut the official public deficit substantially below the 3% threshold (which will be important for EMU readiness) in good times, which adds some risk to Croatia's strategy of targeting fast-track EMU entry. Moreover, state guarantees to companies, mostly state-owned, loss-making firms (including the shipyards), have continued to increase over the last years as they represent the most popular off-budget means to subsidize. During the last four years, the Croatian Bank for Reconstruction and Development (HBOR) has clearly expanded its quasi-fiscal activities, which do not show up in the headline deficit figures. Although the HDZ promised to cut taxes before the parliamentary elections in 2003, only minor changes were implemented. We believe that any future government must cut subsidies, reform public services, and implement reforms in fields of health care and social security, in order to trim expenditures. Especially expenditures for retirees have to be watched closely. They grew strongly over the last years (including 2007's debt repayments) to please the electorate and the HDZ's coalition partner, the HSU (the pensioners' party).

No significant increase in merchandise exports was recorded over the last years, while only a few programmes with minor success were undertaken to boost exports (the latest, called "Croatian Export Offensive", was launched in January 2007). Thus, external imbalances are mostly driven by the increasing trade deficit, although tourism receipts from abroad grew strongly. The current account deficit remains significant, although FDI inflows have recorded strong growth in recent years. However, the structure of FDI remained unfavourable, as most of FDI were associated with capital increases in the banking sector. Only very few "greenfield" investments in the production sector were realized. Thus, FDI did not contribute to industrial upgrading and a rise in the competitiveness of exporters.

Over the last four years, the Croatian equity market experienced a significant development in terms of market depth, market volume and performance. Currently, 441 shares are listed on Zagreb Stock Exchange (ZSE), and around 60 are actively traded. At the end of October 2007, ZSE market capitalization stood at HRK353.1bn. The CROEMI index achieved an outstanding 55% return this year, and the value of net assets under management by investment funds grew strongly as well. At the same time, almost every share experienced price increases, mostly as a result of huge market liquidity, keen interest of (domestic institutional) investors and the overall increased awareness of capital market investing by the general public. The Croatian equity market was enhanced with several IPOs, which, in addition to pension and investment funds, attracted strong interest from the broad public. This interest was sustained by major privatization projects via IPOs, which allowed citizens to buy shares of the largest domestic companies at preferred terms (oil, telecom). In this manner, not only was the equity market boosted but privatizations were conducted in a very transparent manner, which is always at issue while dealing with the EU and the IMF. These equity market trends can be interpreted as one of the most important achievements of the current government.

In the political sphere (with a focus on foreign policy), the current government made some landmark achievements. The most important political success was the start of EU membership negotiations (although the previous government set the path for Euro-Atlantic integration as well as EU accession, ie. signing a Stabilization and Association Agreement). Starting negotiations was also a landmark in regional terms, as Croatia had to prove credible cooperation with the Hague Tribunal. Furthermore and thanks to prudent foreign policy, Croatia has gained a position as leading regional power in SEE regarding stabilization as well as cooperation within the region in recent years (eg. in the process of drafting and signing the CEFTA agreement). Cooperation with neighbours, although troubled by deep-rooted disputes, improved. Moreover, Croatia became one of the leading countries in SEE implementing democratic reforms. Consequently, Croatian elections will not fall short of OSCE commitments and international democratic standards, although there was some pressure from the OSCE and EU in the past to reform and clarify election laws.

In anticipation of an invitation to observe parliamentary elections, the OSCE decided not to deploy a short-term observer mission. Nevertheless some border disputes with neighbours (including EU member Slovenia or Bosnia and Herzegovina) are not settled yet and international bodies might have to be involved in the process of final border determination. But for all that, Croatia's progress was recognized internationally, as the country was elected as non-permanent member of the UN Security Council from 2008 on (having once been the subject of the Security Council). It is expected that Croatia will be invited to join NATO in 2008.

While presenting the latest Progress Report on Croatia in early November 2007 the EU Enlargement Commissioner confirmed that Croatia is "increasingly becoming a positive benchmark for the other countries of the Western Balkans". However, some deep structural reforms are still needed to fulfil EU standards. The judiciary, the public sector and corruption in everyday life remain hot issues. And in addition to already mentioned plaudit, the latest EU Progress Report pointed out that these areas are the most problematic ones in assessing Croatia's EU readiness. Despite the aforementioned shortfalls, the EU concluded that, in general, Croatia meets all the Copenhagen political criteria, which require stability of institutions guaranteeing democracy, the rule of law and human rights as well as respect for and protection of minorities. Nonetheless, the recent Progress Report also showed that 2008 will be a very crucial year to speed-up the EU negotiation process by faster implementation of structural reforms and harmonization of legislation with EU standards. Otherwise, the national goal of becoming the 28th EU member by the end of the decade (which is still the ambitious goal set by the government in power) seems out of reach.

Pre- and post-election issues

PM Sanader from the HDZ heads a centre-right coalition with participation of the HSLS (Croatian Social Liberal Party), the HSU (Croatian Party of Pensioners), and the SDSS (Independent Democratic Serbian Party). The HDZ has won all but one election, as the SDP came to power leading a centre-left coalition in 2000. About 4.4m people (including Croats living abroad) are eligible to cast votes for up to 160 Sabor deputies being elected in 12 constituencies. At most, 12 seats are reserved for Croats living abroad (eleventh electorate) while the exact number depends on the voter turnout within the country (ten electorates). Eight seats are reserved for representatives of Croatia's ethnic minorities (twelfth electorate).

Earlier polls hinted at a SDP victory (in spring and summer, the SDP was in the lead by up to 10%) or at least indicated a slight advantage for the SDP over the HDZ. It looked like the HDZ could not secure an incumbent or EU-related bonus. Although the HDZ's term in government was a success in terms of macroeconomic stability and EU integration, the large share of people still dissatisfied with their living standard gives rise to protest voter potential. Thus, for most of the time in 2007, it looked likely that Croatia might be a victim of the "Eastern European reform country" malady (ie. the phenomenon that almost all impatient democratic reform societies have voted out their governments after one legislative period).

But now pollsters forecast a tight race between the HDZ and the SDP, as the SDP lead has dwindled over the weeks. This trend might be bolstered by various government actions to "convince" numerous social groups throughout 2007 (from the sale of shares of Croatian Telecom, increases in child and maternity benefits and free school textbooks to the announced payment of outstanding pensions to the start of large infrastructure projects as well as lobbying among Croats living abroad). The most recent survey carried out in late October (within a sample of 4,000 respondents) showed the HDZ and the SDP are tied, both with support of 30%.

Thus, still undecided voters might be decisive. Some polls show that up to this day undecided voters may favour the SDP. However, as always the HDZ can count on its strong support by voters abroad (as well as by ethnic minorities in the country). The HDZ might also enjoy some tailwind due to recent war crime trials by the Hague Tribunal. The court rendered judgement on three former Yugoslav army officers (the "Vukovar-Troika") indicted for killing Croatian prisoners of war, but the Croatian public assesses the judgements (including one verdict of not guilty) as too mild. All in all, a neck-in-neck race is still very likely and the hiring of well-know foreign spin doctors for this year's election campaign by both leading parties is a good indication of this expected outcome.

As forecasters stress that one has to account for inaccuracies up to +/- 5% in their recent polls, the upcoming election is still undecided. Regardless of the exact results, either the HDZ or SDP will have to seek the support of smaller parties and/or independents. But the question of who might be supported by whom is very convoluted.

The HNS (Croatian People's Party) will most probably form a coalition with the SDP, but it is questionable whether that will be enough for a parliamentary majority. Because most other parties, ie. the HSP (Croatian Party of Rights), the HSS (Croatian Peasants' Party), the HSLS (Croatian Social Liberal Party), and the HSU (Croatian Party of Pensioners) are more likely to support the HDZ. The HSU has become one of the most popular coalition partners, as its popularity rose after securing the repayment of decade-old state debt to pensioners recently. The HSU has not revealed its future allegiance yet. Its aim is the improvement of the living standards of 1m pensioners, who make up almost one-quarter of the population and many of whom live in very modest conditions.

The HSU supported the HDZ the last years. However, its party leader made clear that the HSU does not have a deep-rooted political orientation. Thus, its affiliation with the HDZ might unravel quickly if the general political climate changes. While the basic positions of the HDZ and the SDP do differ on certain economic, judicial and social issues, neither the HDZ nor the SDP would alter Croatia's Euro-Atlantic integration and pro-Western course (i.e. Croatia's accession to the EU and NATO). In contrast to some SEE countries, there is a broad unquestionable consensus among important politicians and parties regarding EU integration; eg. the current opposition leader Zoran Milanovic (SDP) chairs a parliamentary body dealing with EU negotiations, the National Committee.

Nevertheless, some subtle differences in economic policy might materialize. A HDZ-led government should continue with large-scale infrastructure projects (transport, energy and irrigation) and will likely avoid new taxes and wide scale changes in taxation. Such a policy might result in pressure on fiscal targets, although the HDZ announced it would continue with fiscal consolidation. But fiscal consolidation would presume a decreasing share of government expenditures in GDP. Such a policy was not followed in 2007, when strong revenue growth covered significant expenditures increases. The current high level of expenditures, supported by the HDZ and motivated by desires to please the electorate, puts fiscal consolidation at risk if the economy slows down. Nevertheless, continuation of HDZ rule could result in continuity in recently launched government projects which could be supportive for the overall economic climate if conducted properly.

Andrew MacDowall in Zagreb - Croatia’s conservative opposition has eked out a narrow victory in parliamentary elections on November 8, but having fallen well short of a majority after running a ... more

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